1. Consolidation Week 3 u Inter -company transactions TEXT CHAP 16

2. Adjustments u Previously stated that there was two major adjustments entries for consolidations :- 1) pre-acquisition entry/revaluation entry 2) eliminations of intercompany balances & transactions whereby profits or losses are made by different members of the economic entity through trading with each other

3. Intercompany transactions u Eliminations of intercompany transactions u Transfers of assets € sales of inventory € sales of depreciable assets u Services u Dividends (post acquisition) u Borrowings AASB 1024 EFFECT OF TRANSACTIONS BETWEEN ENTITIES SHALL BE ELIMINATED AASB 1024 EFFECT OF TRANSACTIONS BETWEEN ENTITIES SHALL BE ELIMINATED

4. Intercompany sales of inventory u Assume H Ltd owns all the shares of S Ltd & that consolidation is being carried out on 30 June 19x1, for the year ended on that date. Assume also tax rate of 30%. u Assume that on 1 January, H ltd purchased $10,000 worth of inventory for cash from S Ltd. The inventory had cost S Ltd $8,000.

5. Closing stock adjustment u Assume that on 1 January, H Ltd purchased $10,000 worth of inventory for cash from S Ltd. The inventory had cost S Ltd $8,000. Both companies use periodic inventory system. u Assume inventory unsold by H Ltd at the end of year

6. Intercompany sales of inventory u Assume H Ltd owns all the shares of S Ltd & that consolidation is being carried out on 30 June 19x1, for the year ended on that date. Assume also tax rate of 30%. u Assume that on 1 January, H ltd purchased $10,000 worth of inventory for cash from S Ltd. The inventory had cost S Ltd $8,000. Entries in S Ltd Dr Cash 10 000 Cr Sales 10 000 Dr Cost of Sales 8 000 Cr Inventory 8 000 Entries in H Ltd Dr Inventory 10 000 Cr Cash 10 000 Entries in S Ltd Dr Cash 10 000 Cr Sales 10 000 Dr Cost of Sales 8 000 Cr Inventory 8 000 Entries in H Ltd Dr Inventory 10 000 Cr Cash 10 000

7. Intercompany sales of inventory u Assume H Ltd owns all the shares of S Ltd & that consolidation is being carried out on 30 June 19x1, for the year ended on that date. Assume also tax rate of 30%. u Assume that on 1 January, H ltd purchased $10,000 worth of inventory for cash from S Ltd. The inventory had cost S Ltd $8,000. Consolidation entries Remove internal entries Dr Sales 10 000 (sales not made external to group) Cr Cost of Sales 8 000 (not sold external to group) Cr Inventory 2 000 (shown @ $10 000 actually only $8000) Consolidation entries Remove internal entries Dr Sales 10 000 (sales not made external to group) Cr Cost of Sales 8 000 (not sold external to group) Cr Inventory 2 000 (shown @ $10 000 actually only $8000) Entries in S Ltd Dr Cash 10 000 Cr Sales 10 000 Dr Cost of Sales 8 000 Cr Inventory 8 000 Entries in H Ltd Dr Inventory 10 000 Cr Cash 10 000 Entries in S Ltd Dr Cash 10 000 Cr Sales 10 000 Dr Cost of Sales 8 000 Cr Inventory 8 000 Entries in H Ltd Dr Inventory 10 000 Cr Cash 10 000

8. Intercompany sales of inventory u Assume H Ltd owns all the shares of S Ltd & that consolidation is being carried out on 30 June 19x1, for the year ended on that date. Assume also tax rate of 30%. u Assume that on 1 January, H ltd purchased $10,000 worth of inventory for cash from S Ltd. The inventory had cost S Ltd $8,000. Consider tax effect of consolidation entry Reduced carrying amount of the asset : THEREFORE CREATED a DTD which leads to a Deferred tax Asset DR Deferred Tax Asset 600 CR Tax Expense 600 Consider tax effect of consolidation entry Reduced carrying amount of the asset : THEREFORE CREATED a DTD which leads to a Deferred tax Asset DR Deferred Tax Asset 600 CR Tax Expense 600 Consolidation entries Remove internal entries Dr Sales 10 000 (sales not made external to group) Cr Cost of Sales 8 000 (not sold external to group) Cr Inventory 2 000 (shown @ $10 000 actually only $8000) Consolidation entries Remove internal entries Dr Sales 10 000 (sales not made external to group) Cr Cost of Sales 8 000 (not sold external to group) Cr Inventory 2 000 (shown @ $10 000 actually only $8000)

9. Adjustment entry for unrealised profit in closing stock DR Sales Revenue (inter-entity sale) CR Cost of Sales ( inter-entity cost of sales) CR Inventory (Unrealised profits on opening inventory) DR Deferred Tax Asset CR Income Tax Expense

10. Closing stock adjustment u Assume that on 1 January, H Ltd purchased $10,000 worth of inventory for cash from S Ltd. The inventory had cost S Ltd $8,000. Both companies use periodic inventory system. u Assume half inventory unsold by H Ltd at the end of year SAME EXAMPLE

11. Intercompany sales of inventory u Assume H Ltd owns all the shares of S Ltd & that consolidation is being carried out on 30 June 19x1, for the year ended on that date. Assume also tax rate of 30%. u Assume that on 1 January, H ltd purchased $10,000 worth of inventory for cash from S Ltd. The inventory had cost S Ltd $8,000. Entries in S Ltd Dr Cash 10 000 Cr Sales 10 000 Dr Cost of Sales 8 000 Cr Inventory 8 000 Entries in H Ltd Dr Inventory 10 000 Cr Cash 10 000 Entries in S Ltd Dr Cash 10 000 Cr Sales 10 000 Dr Cost of Sales 8 000 Cr Inventory 8 000 Entries in H Ltd Dr Inventory 10 000 Cr Cash 10 000 Consolidation entries Remove internal entries Dr Sales 10 000 Cr Cost of Sales 9 000 (recorded 8000+5000-4000 what it should be) Cr Inventory 1 000 (unrealised profit 50%) Dr Deferred Tax Asset 300 CR Income Tax Expense 300 Consolidation entries Remove internal entries Dr Sales 10 000 Cr Cost of Sales 9 000 (recorded 8000+5000-4000 what it should be) Cr Inventory 1 000 (unrealised profit 50%) Dr Deferred Tax Asset 300 CR Income Tax Expense 300

12. Closing stock adjustment u Assume that on 1 January, H Ltd purchased $10,000 worth of inventory for cash from S Ltd. The inventory had cost S Ltd $8,000. Both companies use periodic inventory system. u Assume inventory sold by H Ltd at the end of year SAME EXAMPLE

13. Intercompany sales of inventory u Assume H Ltd owns all the shares of S Ltd & that consolidation is being carried out on 30 June 19x1, for the year ended on that date. Assume also tax rate of 30%. u Assume that on 1 January, H ltd purchased $10,000 worth of inventory for cash from S Ltd. The inventory had cost S Ltd $8,000. Entries in S Ltd Dr Cash 10 000 Cr Sales 10 000 Dr Cost of Sales 8 000 Cr Inventory 8 000 Entries in H Ltd Dr Inventory 10 000 Cr Cash 10 000 Entries in S Ltd Dr Cash 10 000 Cr Sales 10 000 Dr Cost of Sales 8 000 Cr Inventory 8 000 Entries in H Ltd Dr Inventory 10 000 Cr Cash 10 000 Consolidation entries Remove internal entries Dr Sales 10 000 Cr Cost of Sales 10 000 No tax entry as no adjustment to carrying amount of the asset. Consolidation entries Remove internal entries Dr Sales 10 000 Cr Cost of Sales 10 000 No tax entry as no adjustment to carrying amount of the asset.

14. Opening stock adjustment u Any transferred inventory unsold at the end of one period is still on hand at the beginning of the next period & because consolidation entries are not made in the books, any differences at the end of one period will still exist at the beginning of the next period.

15. Intercompany sales of inventory Assume that on 1 July 2000, S Ltd has on hand inventory worth $7000 purchased from P Ltd in June 2000. The Inventory had previously been purchased for $4500. Tax 30%

16. Intercompany sales of inventory Assume that on 1 July 2000, S Ltd has on hand inventory worth $7000 purchased from P Ltd in June 2000. The Inventory had previously been purchased for $4500. Tax 30% Consolidation entries 30 June 2000 LAST YEAR Dr Sales 7 000 Cr Cost of Sales 4 500 Cr Inventory 2 500 Dr Deferred Tax Asset 750 CR Income Tax Expense 750 Consolidation entries 30 June 2000 LAST YEAR Dr Sales 7 000 Cr Cost of Sales 4 500 Cr Inventory 2 500 Dr Deferred Tax Asset 750 CR Income Tax Expense 750

17. Intercompany sales of inventory Assume that on 1 July 2000, S Ltd has on hand inventory worth $7000 purchased from P Ltd in June 2000. The Inventory had previously been purchased for $4500. Tax 30% Consolidation entries LAST YEAR Dr Sales 7 000 Cr Cost of Sales 4 500 Cr Inventory 2 500 Dr Deferred Tax Asset 750 CR Tax Expense 750 Consolidation entries LAST YEAR Dr Sales 7 000 Cr Cost of Sales 4 500 Cr Inventory 2 500 Dr Deferred Tax Asset 750 CR Tax Expense 750 Consolidation entries THIS YEAR DR Retained Profits 2 500 Cr Cost of Sales 2 500 Dr Tax Expense 750 CR Retained Profits 750 (Deferred tax asset is reversed as Assumed now sold) Consolidation entries THIS YEAR DR Retained Profits 2 500 Cr Cost of Sales 2 500 Dr Tax Expense 750 CR Retained Profits 750 (Deferred tax asset is reversed as Assumed now sold)

18. Opening stock adjustment DR Retained profits ( at begin ) CR Cost of Sales DR Income tax expense CR Retained profits (at begin)

19. Intercompany sales of depreciable assets u Sale »Intercompany profit or loss on the sale of an asset has to be eliminated - i.e. we reduce the sale price of the asset to its book value u dr Proceeds of Sale cr Carrying Amount of Asset cr Asset dr Deferred Tax Asset cr Tax expense u n.b. :: entries when there is a loss u dr Proceeds of Sale cr Carrying Amount of Asset dr Asset drTax Expense cr Deferred Tax Liability

20. Intercompany sales of depreciable assets u Consider depreciation Depreciation should be adjusted to the depreciation on the book value - currently sale price DR ACCUMULATED DEPRECIATION CR DEPRECIATION DR INCOME TAX EXPENSE CR DEFERRED TAX ASSET

21. Example - depreciable asset u Assume H Ltd sold to S Ltd a motor vehicle for $18,500 cash at 1 July 19x0. It had cost H Ltd $20,000 one year ago. Depreciation charged by H Ltd is at 10% per annum on cost and S Ltd applies a rate of 6% on cost.

22. Example - depreciable asset u Assume H Ltd sold to S Ltd a motor vehicle for $18,500 cash at 1 July 19x0. It had cost H Ltd $20,000 one year ago. Depreciation charged by H Ltd is at 10% per annum on cost and S Ltd applies a rate of 6% on cost. IN THE BOOKS :: H LTD PURCHASED $20,000 DEPN (10%) 2,000 B.V. $18,000 SOLD 18,500 GAIN ON SALE $ 500 IN THE BOOKS :: H LTD PURCHASED $20,000 DEPN (10%) 2,000 B.V. $18,000 SOLD 18,500 GAIN ON SALE $ 500

23. Example - depreciable asset u Assume H Ltd sold to S Ltd a motor vehicle for $18,500 cash at 1 July 19x0. It had cost H Ltd $20,000 one year ago. Depreciation charged by H Ltd is at 10% per annum on cost and S Ltd applies a rate of 6% on cost. CONSOLIDATION ADJ. DR Proceeds on Sale 18 500 CR Carrying Amt 18 000 CR M.V. 500 DR Deferred Tax Asset 150 CR Tax Expense 150 CONSOLIDATION ADJ. DR Proceeds on Sale 18 500 CR Carrying Amt 18 000 CR M.V. 500 DR Deferred Tax Asset 150 CR Tax Expense 150

24. Example - depreciable asset u Assume H Ltd sold to S Ltd a motor vehicle for $18,500 cash at 1 July 19x0. It had cost H Ltd $20,000 one year ago. Depreciation charged by H Ltd is at 10% per annum on cost and S Ltd applies a rate of 6% on cost. CONSOLIDATION ADJ. DR Acc. Depn 30 CR Depn Exp 30 (6% $500 ) DR Tax Expense 9 CR Deferred Tax Asset 9 CONSOLIDATION ADJ. DR Acc. Depn 30 CR Depn Exp 30 (6% $500 ) DR Tax Expense 9 CR Deferred Tax Asset 9

25. Example - depreciable asset u Assume H Ltd sold to S Ltd a motor vehicle for $18,500 cash at 1 July 19x0. It had cost H Ltd $20,000 one year ago. Depreciation charged by H Ltd is at 10% per annum on cost and S Ltd applies a rate of 6% on cost. CONSOLIDATION ADJ. DR Proceeds on Sale 18 500 Cr Carrying Amount 18 000 CR M.V. 500 DR Deferred Tax Asset 150 CR Tax Expense 150 DR Acc. Depn 30 CR Depn Exp 30 (6% $500 ) DR Tax Expense 9 CR Deferred Tax Asset 9 CONSOLIDATION ADJ. DR Proceeds on Sale 18 500 Cr Carrying Amount 18 000 CR M.V. 500 DR Deferred Tax Asset 150 CR Tax Expense 150 DR Acc. Depn 30 CR Depn Exp 30 (6% $500 ) DR Tax Expense 9 CR Deferred Tax Asset 9 SUBSEQUENT YEAR DR R.P. ( Begin) 500 CR M.V. 500 DR Def Tax Asset 150 CR R.P. (Begin) 150 DR Acc. Depn 60 CR Depn Exp 30 CR R.P. (Begin) 30 DR Tax Exp 9 DR R.P. (Begin) 9 CR Def Tax Asset 18 RP= RETAINED PROFITS SUBSEQUENT YEAR DR R.P. ( Begin) 500 CR M.V. 500 DR Def Tax Asset 150 CR R.P. (Begin) 150 DR Acc. Depn 60 CR Depn Exp 30 CR R.P. (Begin) 30 DR Tax Exp 9 DR R.P. (Begin) 9 CR Def Tax Asset 18 RP= RETAINED PROFITS

26. Intercompany services u During the year H Ltd offered the services of a specialist employee to S Ltd in return for which S Ltd paid $25,000 to H Ltd.

27. Intercompany services u During the year H Ltd offered the services of a specialist employee to S Ltd in return for which S Ltd paid $25,000 to H Ltd. ENTRY DR SERVICES REVENUE 25,000 CR SERVICES PAID 25,000 ENTRY DR SERVICES REVENUE 25,000 CR SERVICES PAID 25,000

28. Post acquisition dividends u Dividends declared but not paid Entries in the books –Subsidiary DR Dividend Provided (Retained Profits) 25 000 CR Provision for Dividend 25 000 – Holding Coy Dr Dividend Receivable 25 000 Cr Dividend Revenue 25 000

29. Post acquisition dividends u Dividends declared but not paid Entries in the books –Subsidiary DR Dividend Provided (Retained Profits) CR Provision for Dividend – Holding Coy Dr Dividend Receivable Cr Dividend Revenue CONSOLIDATION ENTRIES DR Provision for Dividend 25,000 CR Dividend Provided 25,000 DR Dividend Revenue 25,000 Cr Dividend Receivable 25,000 CONSOLIDATION ENTRIES DR Provision for Dividend 25,000 CR Dividend Provided 25,000 DR Dividend Revenue 25,000 Cr Dividend Receivable 25,000

30. Post acquisition dividends u Dividends declared and paid Entries in the books –Subsidiary DR Dividend Paid - retained profits 4 000 CR Cash 4 000 – Holding Coy Dr Cash 4 000 Cr Dividend Revenue 4 000

31. Post acquisition dividends u Dividends declared and paid Entries in the books –Subsidiary DR Dividend Paid - retained profits 4 000 CR Cash 4 000 – Holding Coy Dr Cash 4 000 Cr Dividend Revenue 4 000 CONSOLIDATION ENTRIES DR Dividend Revenue 4 000 CR Dividend Paid 4 000 CONSOLIDATION ENTRIES DR Dividend Revenue 4 000 CR Dividend Paid 4 000

32. Intercompany borrowings u H Ltd lends S Ltd $1,000 the latter paying $50 interest

33. Intercompany borrowings u H Ltd lends S Ltd $1,000, the latter paying $50 interest ENTRY:: DR S LTD 1,000 CR H LTD 1,000 DR INT REVENUE 50 CR INT PAID 50 ENTRY:: DR S LTD 1,000 CR H LTD 1,000 DR INT REVENUE 50 CR INT PAID 50

34. Intercompany borrowings u One type of intercompany borrowing is the issue of debentures Assume that on 1 January 19x0, H Ltd issues 1,000 $100 debentures having interest of 15% per annum payable on 1 January each year. S Ltd its subsidiary acquires half of the debentures issued.

35. Intercompany borrowings u One type of intercompany borrowing is the issue of debentures Assume that on 1 January 19x0, H Ltd issues 1,000 $100 debentures having interest of 15% per annum payable on 1 January each year. S Ltd its subsidiary acquires half of the debentures issued. ENTRY:: DR DEBENTURES 50,000 CR DEBENTURES IN H LTD 50,000 DR INTEREST REVENUE 7,500 CR INTEREST EXPENSE 7,500

36. Tutorial questions Exercise 16.1 Exercise 16.5 Problem 16.2 Problem 16.4 Problem 16.5